S&P Global Ratings projects moderating local and regional government (LRG) borrowings in developed markets (DMs) in 2023-2024 after debt accumulation surged throughout the COVID-19 pandemic. We anticipate that gross U.S. dollar borrowings will decline this year, but recover in 2024 to total about $920 billion, nominally similar to pre-pandemic figures (see chart 1). We project that most funding needs will be met through the capital markets either directly--as in the case of large issuers in Germany, Japan, Canada, and Australia--or via public-sector funding agencies (PSFAs), which help smaller entities to access debt capital market funding. With monetary tightening policies being implemented across the DMs, we expect the supply of subnational bonds available for market participants to increase substantially this year.

Across the developed world, many LRGs outperformed our forecasts in 2022 on the back of the positive short-term effects of rising inflation and high commodity prices. At the same time, continued central government support, albeit at lower levels than in 2020-2021, contributed to a solid operating performance. As a result, we estimate that net borrowings outside the U.S. bottomed out in 2022.

Chart 1

We observe divergences in investment policy and borrowing trends depending on the severity of fiscal frameworks. While subnational governments in Australia and Canada will focus on longer-term issues, such as changing demographics, infrastructure investments, and decarbonization, European LRGs will prioritize budgetary consolidation amid the war in Ukraine and inflation-induced spending pressures. Australian and Canadian LRGs do not have any external fiscal rules, giving them more flexibility to carry out investments and maintain budgetary deficits. At the same time, we project lower debt accumulation in many European countries, while tighter fiscal rules will be restored after they were suspended at the onset of the pandemic. For instance, we expect German states to scale down capital expenditure (capex) to comply with the debt brake rule, which requires them to run structurally balanced budgets.

Across the DMs, inflationary pressures and monetary tightening are dampening consumer confidence and contributing to a perceived cost-of-living crisis. This will translate into slower economic and revenue growth, while spending will increase to catch up with inflation.

In light of intensifying budgetary pressures, we believe there is greater uncertainty around whether fiscal rules will remain intact, especially in Europe. Ongoing discussions about potentially revising the fiscal rules in the EU's Stability and Growth Pact could affect national legislation in Germany and other EU countries, changing the playing field for German states in terms of capex and the debt brake rule. If European countries, collectively or individually, were to loosen fiscal restrictions, this would most likely lead to higher borrowings than we assume in our current base case.

Other risks to our forecast include elevated inflation, continuous supply-chain constraints, and limited administrative capacity, which make it difficult to implement capex on time, delaying investment and borrowing. We also think that the complicated geopolitical environment, especially in light of the ongoing Russia-Ukraine war, brings uncertainty to LRGs' financial planning, especially in Europe.

Budgetary Deficits Will Shrink Amid Differences In Fiscal Policy

We project that DM LRGs' funding gaps will narrow, on average, through 2024 (see chart 2). Many subnational governments, primarily in Europe and Japan, will achieve a close-to-balanced budgetary performance, in line with their restored focus on fiscal consolidation. In Australian states and Canadian provinces, we expect narrower deficits because some of them are benefitting from the global surge in commodity prices. Specifically, strong royalty revenues led the mineral-rich states of Queensland and Western Australia to record sizable budgetary surpluses in 2022.

Chart 2

In 2023-2024, we expect that inflationary pressure on LRGs' expenditures--reflected in elevated wages, energy prices, and other costs--will offset the positive short-term effects on revenues. That said, we expect that many public sector employees will not receive full compensation for higher prices in the economy. We expect that budgetary performance will vary based on the underlying macroeconomic developments, LRGs' revenue structures, spending responsibilities, and the rigidness of fiscal rules.

In Australia and Canada, we anticipate that regional governments will maintain relatively large budgetary deficits. This is because Australian states and Canadian provinces are not constrained by any external fiscal rules, giving them more flexibility to carry out investments and continue to borrow.

We expect low but steady economic growth in Japan in 2023-2024, which should underpin solid tax revenue growth and fiscal equalization transfers from the central government. We expect this to offset the inflationary pressures on Japanese LRGs' expenditures, such as on wages and goods, and result in balanced budgetary performance.

In other DM countries, we expect that LRGs will scale back capex due to the consolidation plans imposed by central governments. In Germany, for example, the return of the temporarily suspended debt brake rules from 2023 underpins our expectations of fiscal discipline and slight deleveraging. Even in countries where the balanced budget requirement excludes capital spending, such as Finland and Sweden, we expect that many LRGs will impose stricter investment priorities to meet self-financing targets.

German States And Canadian Provinces Will Dominate DM Subnational Borrowings

Outside the U.S., German states and Canadian provinces remain the largest group of borrowers among DM subnational governments, followed by Japanese LRGs (see chart 3). In Germany and Japan, subnational borrowings are driven by refinancing needs, while net borrowings are negative; Canadian provinces will also continue to borrow to fund sizable investments.

Chart 3

Australian states' net borrowings will likely surpass those at their Canadian and German peers due to their large budgetary deficits. Sizable funding needs, due to weaker operating performance in the sector, will also drive U.K. LRG borrowings. We forecast that LRGs in the Nordics and Spain will maintain modest net borrowings, reflecting persistent investment needs coupled with less stringent fiscal rules than the rest of Europe.

We forecast that strict budgetary spending constraints in Italy and France will lead to deleveraging, despite notable investment needs. In Switzerland, however, strong revenue growth will achieve the same outcome.

We expect that Japanese LRGs will post budgetary surpluses in the coming years, leading to limited funding needs. However, gross borrowings will remain relatively large due to their refinancing of the existing high debt stock.

Debt Capital Markets Will Remain The Primary Funding Source

We expect DM LRGs' bond issuances to reach the equivalent of $650 billion in 2023, covering around 75% of their funding needs. The U.S., Canada, Australia, and Germany will place about half of this (see chart 4). We expect that the bond supply to market participants will substantially increase as central banks implement monetary tightening, meaning they will buy fewer subnational bonds, if any.

Chart 4

While large regions place own-name bonds, smaller LRGs in the Nordics, France, and Japan access the capital markets via PSFAs. In most cases, LRGs place bonds domestically and in local currency, while PSFAs, Australian states, and some Canadian provinces place bonds in different currencies. Canadian provinces, Australian states, and U.S. public-sector entities also rely entirely on capital markets. German states' funding mix is also shifting in favor of bonds, with bonds now representing nearly two-thirds of outstanding debt, compared with 50% in 2016.

In contrast, Austrian, Italian, and U.K. LRGs meet almost all their funding needs by borrowing from the central government and its agencies. Most Italian subnational borrowings in recent years were loans from state lending arm Cassa Depositi e Prestiti to settle arrears payments and fund long-term investments. Similarly, U.K. LRGs' borrowings are dominated by the government's Public Works Loan Board (PWLB). Due to constraints that the central government has imposed on local authorities' activities, their access to PWLB loans may be restricted, leading to an increase in commercial borrowings. Japanese LRGs also benefit from access to the central government's direct lending scheme.

Debt Will Continue To Rise

We expect that new borrowing will lift DM LRGs' outstanding debt to over $8 trillion by year-end 2024, similar to the 2020 high in nominal terms, or roughly 20% lower in real terms. LRG debt remains highly concentrated geographically, with the U.S. accounting for about 40% of DM subnational debt, followed by Japan, Canada, and Germany, at just under 40% combined (see chart 5).

Chart 5

Canadian LRGs will remain the most indebted globally, with debt to revenue of 180% by year-end 2024, followed by New Zealand, Japan, Australia, and Spain (see chart 6). With borrowing speeding up in Australia, we expect that LRGs will double their debt burden over 2019-2024. However, in Germany and Spain, we expect indebtedness to return to pre-pandemic levels, as LRGs will scale down their capital investments to adhere to deficit containment rules.

Chart 6

Exposure To Rising Interest Rates Is Relatively Low In Europe, But Elevated In Canada and Australia

In our view, the LRGs most exposed to rising interest rates are those with expected high deficits and debt burdens. Canadian provinces and Australian states will see interest payments rising the most, as forecast budgetary pressures result in debt accumulation.

Favorable market conditions in Europe and most other DMs over the past few years have allowed LRGs to build debt portfolios with large proportions of fixed-rate debt and gradual repayment schedules. The share of fixed-rate debt in DM LRGs' debt portfolios in most cases surpasses 90% of total debt. Refinancing needs are relatively limited, with only 5%-15% of direct debt being rolled over each year (see chart 7). Most LRGs rely on long-term borrowings, meaning that the cost of capital is changing very gradually. In most cases, the cost of new debt is still lower than that of legacy debt.

Swedish and Israeli LRGs are somewhat exposed to repricing risk due to their reliance on short-term debt. Swedish local governments rely heavily on issuing 12-month-dated commercial paper to finance their spending, while the Israeli authorities have a considerable amount of debt linked to the consumer price index. However, in both cases, low overall levels of indebtedness and low expected deficits for the coming years mitigate this risk.

Chart 7

Countries Covered In This Report

Our survey on DM LRG borrowing encompasses 18 countries: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Israel, Italy, Japan, New Zealand, Norway, Spain, Sweden, Switzerland, the U.K., and the U.S. We consider this sample representative of DM LRG debt. We have also published separate and more detailed analyses of projected borrowings in the LRG sectors of various regions (see "Related Research" below).

We base our survey on data from statistical offices, as well as on our assessment of the sector's borrowing requirements and outstanding debt, which includes bonds and bank loans. The reported figures are our estimates and do not necessarily reflect LRGs' own projections. For comparison purposes, we present our aggregate data in U.S. dollars.

Table 1

Related Research

• Subnational Debt 2023: An Easing Burden In Germany, Austria, And Switzerland, March 2, 2023
• Subnational Debt 2023: Global Capital Expenditure To Moderate, March 2, 2023
• Subnational Debt 2023: The Best-Placed Local And Regional Governments To Handle Rising Interest Rates, March 2, 2023
• Subnational Debt 2023: Australian States Navigate Crosscurrents Of COVID, Coal, And Capex, Feb. 26, 2023
• The Clock Is Ticking For The Debt-Led Growth Of China Local Governments, Feb. 21, 2023
• Canadian Local And Regional Government Debt: Economic Headwinds Will Slow Debt Sustainability Efforts In Fiscal 2024, Feb. 14, 2023